Business Analytics

Ranking games and gambling: When to quit when you're ahead

Professor Eddie Anderson, University of Sydney

27th Apr 2012 11:00 am - Room 498, Merewether Building (H04)

It is common for rewards to be given on the basis of a rank ordering, so that relative performance amongst a cohort is the criterion. In this paper we formulate an equilibrium model in which an agent makes successive decisions on whether or not to gamble and is rewarded on the basis of a rank ordering of the final position amongst competing players. One application of this model is to the behavior of mutual fund managers who are paid depending on funds under management, which in turn are greatly influenced by annual or quarterly rank orderings. We model a situation in which fund managers can elect either to pick stocks or to use a market tracking strategy. In equilibrium the distribution of the final position will have a negative skew. We explore how this distribution depends on the number of players, the probability of success when gambling, the structure of the rewards, and on information regarding the performance of other players.